In order to address the financial incentives that have driven, in part, the construction of specialty hospitals, CMS has proposed an update to the hospital inpatient prospective payment system for fiscal year 2008. While the payments for FY 2008 will increase payments to all hospitals on an average of 3.3 percent, the bulk of the increase will go to hospitals treating patients with the most serious illnesses. The proposed change includes the adoption of a severity diagnosis related group (DRG) system, called the Medicare-Severity DRGs. Considered in the mid-1990s, CMS formally proposed the new Medicare-Severity DRGs, replacing the current 538 DRGs with 745. The proposal will be budget neutral, meaning that CMS will increase payments under certain DRGs (those reflecting more severe patient conditions) and will decrease payments under other DRGs. The impact of budget neutrality will be felt most heavily on specialty hospitals which currently treat the healthier, least costly patients compared to the sicker, more costly patients of full-service hospitals. For example, CMS’s proposal will likely reduce payments to cardiac specialty hospitals by approximately 4 percent. In addition to the new Medicare-Severity DRGs, CMS is asking for additional public comment on whether CMS should expand from 13 to 19 hospital departments used by CMS to weigh DRGs and provide improved payment accuracy.